Thursday, March 25, 2010

I keep coming back to this chart, which I have shown many times since Nov. '08, because it has done such a good job of explaining both the origins of the great financial panic of '08 and the mechanism for recovery. The whole mess got started because the world feared the collapse of the global banking system. Fear, panic, doubt, uncertainty—all the things that drive the Vix index—spiked to epic levels, and as a result, spending and investment ground to a halt. Then came the Obama panic of early '09, when he called for a trillion dollars of faux-stimulus spending and trillion-dollar deficits for as far as the eye could see, which in turn deflated markets as they contemplated a massive increase in future tax burdens.

As the financial markets gradually healed themselves, with help from the Federal Reserve's (belated) decision to provide essentially unlimited amounts of liquidity to the system, the fears started to dissipate, the spending began to restart, the global economy began to make a comeback, and the price of risky assets began to rise. Although this recovery process has been underway for almost 17 months, we have still not fully recovered, and we are still living under the threat of out-of-control federal spending and its eventual consequences. But we are making progress, and the progress should continue, especially if the electorate in November expresses a strong desire to return to fiscal discipline, as I think it will.

6 comments:

Thanks for keeping this front and center. Another 'tell' is Best Buy's earnings this morning. Bodes well for techland. Bank stocks are breaking out of a long base going back to early last fall. It appears the market is seeing the stabilization of real estate prices and translating it to fewer land mines exploding on banks' balance sheets. Are 'write ups' just around the corner? When the banks start lending again I look for the fed to start thinking about raising rates a little. Lastly, Ben's testimony this morning was a good read. The fed paying interest on bank reserves is an interesting twist. Fear is indeed subsiding and markets are responding.

I suspect that there are many billions of assets on the balance sheets of banks and corporations that are just waiting to be "written up." The stabilization of the real estate market is the key to the recovery of prices of many asset-backed securities that were written down a year or so ago. The good news will likely just keep on comin'.

Big rally on DJI today. There is gobs of cash everywhere, and the globe generates huge amounts of investable capital every year--high savings rates in Europe, and Asia.

We may have a rally here, even a secular rally. After all, the DJI is still below 1999 levels.

I agree with Scott G. on one thing: If somehow the US government can convince the market that it will not be a chronic borrower (and that entails some reality behind the convincing), we could have a rally for the ages.

Scott, You make the point that "the progress should continue, especially if the electorate in November expresses a strong desire to return to fiscal discipline, as I think it will."

While I know that your focus is primarily economics, what is your thought about the possibility of a changed Congress actually exhibiting the capability to carry out their constituent's desire for "fiscal discipline." Our choice is basically Republicans vs. Democrats which doesn't necessarily mean fiscal conservatism vs relentless spending.

To begin with, let me emphasize that politics can be extremely important for economics. Supremely important, especially at times like now when our federal government has abandoned all pretense of fiscal discipline. I've written quite a few times in the past several months that I think we have passed a major "tipping point" in U.S. politics, and the election of Scott Brown was a good sign of that happening. I think the electorate is waking up to the fact of our fiscal indiscipline, and I think that is going to be the major focus of political discussion for the foreseeable future. The Tea Parties are another good example of this.

I expect to see huge defeats for the Democratic Party in the Novemember elections. I expect the elections to be a clear referendum on not only the healthcare bill but also on the overall conduct and direction of fiscal policy. I think the people are getting really upset, and they are going to demand a major recalibration of fiscal policy.

The Republican Party will only be successful in November to the extent that it focuses on the need to reduce spending and not increase taxes. Anything else is a distraction.